Framing Disruption Risk

This article originally appeared on NACD BoardTalk Blog on August 20, 2018

Not a week goes by without more evidence that big, tectonic shifts are reshaping the world. How people live and work, the structure of industries, and the vitality of organizations evolves at incredible speed.

Disruption caused by technology, the proliferation of data, human behavior, society, and regulation are not new to the risk agenda. But a new kind of risk has surfaced—disruption risk—and it is significant for two inter-related reasons. First, it does not have a “home” since it does not naturally fit within organization’s risk structures today. Second, most organizations are having speculative conversations about disruption when a disciplined approach to measurement and management is in order.

While singular trends can have an impact on earnings, disruption risk increases when trends collide.

We define disruption risk as risks that would lead to fundamentally altering the financial prospects of an industry and companies within it. If we play out scenarios considering the speed and evolution of these forces, it becomes clear that current management practices cannot stem an inexorable erosion of revenue and competitiveness.

While singular trends can have an impact on earnings, disruption risk increases when trends collide. As an example, the rise of Uber Technologies and Lyft, and the decline of traditional taxi and limousine services and car rentals, was the product of many forces: the availability of mobile devices and simple apps; density of urban areas; and the underserved need to get from point A to point B, reliably and friction-free.

At first glance, these forces and collisions may seem so complex as to be confounding. Many hours of executive and board time have been spent on the notion of disruption. Directors find themselves asking one another questions: “Is ‘Big Tech’ coming for our business? Is some other powerful player entering our market from some near-adjacency—armed with some unique capability, or with a capital-efficient business model?” But disruption risk needs to be elevated from an occasional topic of discussion to a management discipline—one that frames and systematically probes disruption risks present in the business and places bets to create options for the future.

This discipline has three key ingredients:

A framework that is simple enough to employ, but comprehensive enough to highlight the areas of greatest risk;
A place in the organization to operationalize the review of such risks; and
The mindshare of senior executives and board members to systematically discuss areas of risk, opportunity, and potential action.

A framework to assess disruption risk

In terms of a framework to highlight the areas of greatest risks, disruption risk can be examined through honest assessment of these four indicators and your business model:

The higher the forecast margin and profit, the greater the risk some other player will seize it.
The lower the level of value created for the customer, the greater the risk that someone will improve customer value.
The lower the protective barriers around an industry, the greater the risk that an outsider will enter and reshape the basis of competition in their favor.
The further away from the frontier of manufacturing and distribution capability that an organization is, the greater the risk from substitutes that create dramatic cycle time and margin pressure.

The first two indicators can serve as a powerful magnifying lens for determining where organizations should be most concerned about new entrants wanting to disrupt them—specifically, where value creation for the shareholder is high, and value creation for the customer is low. Several easy-to-grasp examples of these in financial services include high balance depositors in low yield products, high-fee current account customers, or low-risk borrowers with overpriced loans.

The second two indicators can help assess how likely—and with what velocity and impact—entrants will be able to show up on an organization’s doorstep. Could new entrants leverage significantly more advanced capabilities to improve manufacturing or delivery, and are there material barriers or accelerators to their success?

Taking action

Armed with insights about disruption risk, a leadership team can direct efforts to mitigate risk, fortify existing earnings, and create optionality to onboard new sources of value to replace earnings streams that face unavoidable decline. Ultimately this results in a portfolio of activities that guides the organization to a projected future of disruption benefit rather than risk and loss. These can include:

Transformative innovations that will capture new areas of customer value and generate incremental shareholder value from bridging customer value gaps.
Performance innovations that will maximize the long-term value creation from existing businesses—even in the face of disruptive threats.
Productivity businesses, activities, or assets where the organization acknowledges the unavoidable threat of disruption risk and reallocates management attention and resource from these areas to fund transformative or performance innovation.

Disruption risk mounts for those who fail to acknowledge it and take a clinical, dispassionate view toward measuring and managing it: wait too long, and the sources of value may have eroded faster than the capacity of the organization to race to the future. On the other hand, future market leaders will manage disruption risk and channel it in their favor, and begin by answering three simple decisions: